A very optimistic estimate of the cumulative future dividend of WHX is $225m. The company sells for $250m. In any case, WHX is certain to go to $0. This can reasonably be expected by 2017.

I use rough numbers because I don’t like calculators and spreadsheets. My numers are from the latest 10q and 10k. http://www.sec.gov/cgi-bin/browse-edgar?company=&match=&CIK=whx&filenum=&State=&Country=&SIC=&owner=exclude&Find=Find+Companies&action=getcompany

The company

Whiting USA Trust has no material asset other than the right to receive 90% of the net proceeds of some oil and natural gas producing properties in the Rocky Mountains, Mid-Continent, Permian Basin and Gulf Coast regions. After 9 MMBOE have been produced, the Trust will wind up its affairs and terminate. The 9 MMBOE are projected to be produced by 2017. Production is approximately 60% oil and 40% natural gas. The Trust distributes its earnings quarterly. Payments represent a return of investment (tax exempt !).

Intrinsic Value

This is my kind of DCF. The trust has roughly 5 MMBOE remaining; it started out with 9 MMBOE in 2007.

With oil at $100, 5 MMBOE is worth $500m.

The market cap is $250m. This implies a healthy double digit discount rate assuming it takes five years to pump up the remaining 5 MMBOE.

I can see why mr. Market is willing to pay $250m.

Wrong !

Remember the first half of 2008 ? Oil was at all-time highs; $130 - $140. Back then, the Trust distributed a record of 45m per MMBOE produced. At best, we can expect 5 x 45m = $ 225m for the 5 MMBOE remaining.

Those record distributions of 45m per BBOE were made at record prices for oil and a much better production mix (more oil, less gas). http://www.sec.gov/Archives/edgar/data/1417003/000095013408009256/d56799exv99w1.htm

Why the difference ?

In short, at $ 100 oil, 5m BOE is worth less than $ 500m if they're underground.

2) We didn't account for the fact that 40% of production is natural gas. A BOE of natural gas is about 60% cheaper than a barrel of oil.

3) We didn't account for the fact that the Trust has a right to just 90% of net proceeds.

I leave it to the reader to find a recent transaction of US oil reserves implying a value of more than $25 per BOE and that's oil not 40% gas. http://www.ogfj.com/index/article-display/6476170160/articles/oil-gas-financial-journal/volume-7/issue-10/deal-monitor/linn-energy-s-permian-basin-deal-is-month-s.html http://www.worldoil.com/Energy_XXI_to_purchase_GOM_fields_from_Exxon_for_1.01_billion.html

Intrinsic value II

We use a 5% discount rate to find the present value of that $225m…... let’s just say WHX is not reasonably worth a dime over $ 200m.

Mr. Market says this is a bet on rising oil and/or gas.

He’s wrong ! WHX hedges. Between now and january 2013 the price is capped at $145 per barrel of oil and $7 per Mcf of gas (=$42 / BOE). Oil must go over $200 for WHX to get that maximum hedged price of $145.

Risks

1) Oil could run up over $200 and stay there causing distributions to come in at record levels going forward. One could hedge this out with some 2015 oil futures….. arbitrage.

2) A short squeeze can be painful. Make sure you are in a position to make this an opportunity instead of a threat. Remember, WHX is certain to go to zero eventually.

The nice thing about shorting is that the 873465 risks I haven't thought of, invert.

Links

Even more bearish: http://www.citronresearch.com/index.php/2011/01/24/another-stock-only-a-computer-could-love-the-sequel/

About the author:

batbeer2

I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

I am doing the math (and I am being conservative...), but lets say we go middle of the road and the dividend payout is 200m. If the stock is currently selling at 250m, that is a 20% return IF I hold it until it expires 5 or 6 years from now. That is a really poor annualized return for the risks that are involved. I do think you are right in that there is a slight margin of safety, I don't see someone really losing money on a short like this, but... I just don't know if it is worth the time.

that is a 20% return IF I hold it until it expires 5 or 6 years from now.

Excuse my round numbers.... the shares are all over the place.

Let's take plain vanilla short selling as I understand it.....

You sell 5 shares you don't own for $20. You collect $ 100. You slowly deplete that $ 100 "coughing up the dividends". According to my calculations you can reasonably expect to end up holding $20 by 2017.

The $20 is the numerator of the "return" what's the denominator; your invested capital ?

Well, just FYI. I am only allowed to short to a certain dollar value at any given time based on the other assets that I own.... So, shorts aren't just "free" money. The shares are technically "borrowed" from the broker that I am doing business with and I have to pay interest on that money or asset. (Think leverage) So really, the denominator is however much you borrow originally and the numerator is the difference between what you borrow originally and what you pay back at the end. In this case, you are borrowing 250 from someone who owns the shares and you plan to pay back (hypothetically) 200. That gives you the numerator of 50 (and this is assuming paying 0% on the borrowed 250). Does that help?

I've read through the 2009 10K and the 3Q 2010 10Q, and FWIW here are a few comments about WHX:

-- The oil hedges are actually collars that put a floor of $74 and a ceiling of $140 on WHX's oil sales in 2011 and 2012. The gas hedges are also collars with a floor of about $6-7 during 2011 and 2012. Though the gas hedges have ceilings they are unlikely to be met. While the oil hedges allow for some variability in the pricing with the changes in the market prices, the gas hedges are actually a good thing since the floor is significantly above current market prices.

-- The price that WHX receives from oil sales are materially different from the NYMX quoted futures price since they receive a regional cash price. One should expect that WHX likely actually receives about $8-10 below the futures price (unless the field price is below the hedge floor or above the ceiling).

-- The actual reserves that the Trust is entitled to from inception was 8.2 MMBOE (90% X 9.11 MMBOE). As of the end of 2009 the estimated reserves that the Trust was entitled to was reported to be 5.433 MMBOE (2009 10K). During the first 3 quarters of 2010 the Trust's share of production was reported to be 1.021 MMBOE (from 3Q 2010 10Q). If one assumes that the 4Q 2010 production was similar to the 3Q production of .340 MMBOE, then the estimated Trust owned reserves at the end of 2010 was about 4.072 MMBOE (5.433 - 1.021 - .340).

-- Since there are 13,863,889 Trust units outstanding, each unit was the beneficial owner of an estimated .29 BOE of reserves (4.072 MMBOE / 13,863,889 units) at the end of 2010. At a current price of about $17/unit, an investor will be paying about $58 per BOE ($17 / .29 BOE).

-- WHX does not pay a "dividend"; rather, it pays a "distribution". IMO this could be an important distinction. The distribution actually consists of two components. For example, for a new investor, one component is a return of capital at the rate of $58 per BOE for the produced BOEs during the period for which the distribution is being paid while the other component consists of the balance of the distribution which represents the profit earned for producing and selling those BOEs (net oil price received after deductions less $58/BOE).

-- Average production costs per BOE for 2009 were reported to be about $17. This means that if an investor pays $58/BOE for the reserves and then pays $17/BOE to produce a BOE, then the BOE must sell for $75 to break even ($58 + $17). However this quick and dirty analysis does not take into account the difference between the current oil price and the current gas price on a BTU basis. IMO an investor considering WHX units would want to break out the oil and gas production and sales to understand the impact of the current market conditions on the analysis.

After 9 MMBOE have been produced, the Trust will wind up its affairs and terminate. Mind you, this is not something I think will happen based on some estimate.... this is how this particular business was set up.

So.... if they produce more and quicker, this will only serve to hasten the demise of the trust. If memory serves, any value in the assets (reserves) after that basically belongs to Whiting Petroleum (the company, not the trust).

FWIW, WHX now discloses what is known as the "standardized measure of discounted future cash flows projected to arise from production of proved reserves." In december, it was $ 105m before tax. That's the trusts only asset !

Standardized measure as of December 31, 2010. No provision for federal or state income taxes has been provided because taxable income is passed through to the unitholders of the Trust. Therefore, the standardized measure of the Trust and of the underlying properties is equal to their corresponding pre-tax PV 10% values.

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